Risk & Compliance

Faulty Forecasts on a Roll

Companies that cannot hit targets might consider changing the way they forecast.
Alan RappeportFebruary 11, 2008

Faulty forecasts have been the downfall of many CFOs. Last year the retirement of Motorola’s finance chief, David Devonshire, coincided with the technology company dropping its revenue projections by a billion dollars in the first quarter. At Ericsson, the telecommunications giant, the CFO departed last October after profits came in short and share prices fell by 30 percent.

Despite such consequences, companies are continuing to struggle with accurate forecasts — both internally and in the numbers they report to Wall Street. New research from The Hackett Group, a business consultancy, finds that two-thirds of 70 surveyed U.S. and European companies are missing their forecasted earnings by at least 6 percent, up to a high of 30 percent.

“The mechanisms that companies use to determine their financial outlook are poor determiners for what’s going on,” Brian Hall, of Hackett, told CFO.com. “Commodity prices and consumer confidence all have gone haywire in the last year.”

According to Hackett, the recent spate of volatility is ladling corporations with uncertainty. The number of companies that consider themselves to be at “high risk” of missing forecasts or “high volatility” companies has jumped to 14 percent, from 2 percent three years ago. The answer, says Hackett, is for companies to be less rigid in their forecasting.

One possibility is to switch from year-end to rolling forecasts, which can better capture changes in the markets. “Most models are based on ‘what did you tell me was going to happen last November,’ ” Hall says. “We’re in a dynamic environment.”

Hackett also recommends that companies take a more practical view of those responsible for earnings forecasts. Punishing people for bad news will not necessarily make things better. “You need a process that tries to bring an objective view,” says Hall, explaining that it is important to have a culture where bad news can be communicated early.

Although changes to forecasting practices may be due, the uses of long-term forecasts appear quite entrenched. Last summer the National Investor Relations Institute found that 58 percent of 752 companies surveyed provided annual estimates, while just 27 percent used quarterly estimates. Firms taking a longer view said that it gave them the chance to be more nuanced and that it did not negatively affect valuation or stock prices.

Some companies have tried going in the opposite direction by eliminating earnings guidance altogether, saying it frees them from “market myopia.” However, a recent study called “To Guide or Not to Guide” argues that this is not the answer, as companies scrapping guidance saw no increase in research and development or capital investments. Moreover, 31 percent of the 222 companies reviewed resumed quarterly guidance after 18 months.